UNITED COCONUT PLANTERS BANK, PETITIONER, VS. SPOUSES SAMUEL AND ODETTE BELUSO, RESPONDENTS.

United Coconut Planters Bank versus Spouses Beluso

The Case

This is a petition for review on certiorari brought by United Coconut Planters Bank against Spouses Samuel and Odette Beluso, arising from a credit line secured by a real estate mortgage over parcels of land in Roxas City. The spouses sued to annul the interest rates stipulated in their promissory notes, to obtain an accounting, and to annul the foreclosure of their mortgaged properties. The case matters because it is the Court's clearest teaching on the mutuality of contracts in loan agreements: an interest rate left to the lender's sole will is void, and the void stipulation drags down the foreclosure built upon it. It also gathers in one place the rules on valid demand, legal interest, compounding, iniquitous penalties, and attorney's fees.

Procedural History

The spouses Beluso filed a petition for annulment, accounting, and damages with the Regional Trial Court of Makati City. The trial court ruled for the spouses: it declared the interest rate void, annulled the foreclosure and the sheriff's certificate of sale, ordered the bank to return the properties, ordered the bank to pay fifty thousand pesos in attorney's fees and the costs of suit, and ordered the spouses to pay the bank one million five hundred sixty thousand three hundred eight pesos. The trial court denied the bank's motion for reconsideration.

The bank appealed to the Court of Appeals, which affirmed the trial court but modified the judgment by deleting the award of attorney's fees and the costs of suit against the bank. The Court of Appeals then denied the bank's motion for reconsideration. The bank elevated the case to the Supreme Court by petition for review on certiorari under Rule 45.

Facts

In April 1996, the bank granted the spouses Beluso a promissory notes line under a credit agreement, initially up to one million two hundred thousand pesos, later increased to two million three hundred fifty thousand pesos and extended to the end of February 1998. As additional security, the spouses constituted a real estate mortgage over parcels of land in Roxas City. The spouses drew on the line through several promissory notes, which were renewed from time to time. They claimed that the last two notes, totaling three hundred fifty thousand pesos, were never released to them, so that their principal indebtedness was only two million pesos.

The bank applied interest rates ranging from eighteen to thirty-four percent, and from 1996 to February 1998 the spouses paid a total of seven hundred sixty-three thousand six hundred ninety-two pesos and three centavos. From the end of February 1998 to June 1998, the bank continued to charge interest and penalty, and the spouses made no further payment. In September 1998, the bank demanded payment of two million nine hundred thirty-two thousand five hundred forty-three pesos plus twenty-five percent attorney's fees. In December 1998, the bank foreclosed the mortgaged properties, by which time it claimed the obligation had ballooned to three million seven hundred eighty-four thousand six hundred three pesos.

The spouses then filed their petition for annulment, accounting, and damages. The heart of the dispute was the interest clause in the promissory notes, which fixed interest at a rate indicative of the DBD retail rate or as determined by the Branch Head, and a related clause subjecting the rate to review and adjustment by the lender alone.

Issues

• Whether or not the Court of Appeals erred in affirming the declaration of nullity of the interest rate provision agreed upon between the bank and the spouses.
• Whether or not the Court of Appeals erred in affirming the trial court's computation of the spouses' indebtedness at one million five hundred sixty thousand three hundred eight pesos.
• Whether or not the Court of Appeals erred in affirming the annulment of the foreclosure on the ground of incorrect computation of the indebtedness.
• Whether or not the Court of Appeals erred in finding the bank liable for violation of the Truth in Lending Act.
• Whether or not the Court of Appeals erred in failing to dismiss the case on the ground of forum shopping.

Applicable Provisions

Article 1308 of the Civil Code provides:

Article 1308. The contract must bind both contracting parties; its validity or compliance cannot be left to the will of one of them.

This is the provision the Court applies to strike down the interest clause, because the rate was left to the bank's sole will.

Section 2 of the Truth in Lending Act provides:

Section 2. Declaration of Policy. It is hereby declared to be the policy of the State to protect its citizens from a lack of awareness of the true cost of credit to the user by assuring a full disclosure of such cost with a view of preventing the uninformed use of credit to the detriment of the national economy.

The Court invokes this policy to hold that non-disclosure of the true finance charges is a form of deception that estoppel cannot cure.

Ruling

On the first issue, the Court upheld the Court of Appeals. The interest clause gave the bank two choices: a rate indicative of the DBD retail rate, or a rate as determined by the Branch Head. Both choices depended solely on the bank's will. A rate fixed by the Branch Head leaves him unfettered discretion. The DBD retail rate option is not saved by the Polotan ruling, because in Polotan the parties stipulated a fixed margin of three percent over the prime rate, so the rate could be computed by simple arithmetic; here no margin above or below the DBD retail rate was specified. The review clause likewise failed, because the authority to review belonged to the lender alone and the bank could weigh the enumerated considerations as it wished. The separability clause could not save either option, since both violate mutuality. Estoppel cannot be predicated on an illegal act, and the non-disclosure also offended the Truth in Lending Act.

On the second issue, the Court agreed with the bank in part. Default begins upon judicial or extrajudicial demand, and an excessive demand does not nullify the demand as to the proper amount; otherwise commercial transactions would be thrown into disarray. The spouses were therefore in default as to the correct amount, and interest and penalties began to run. The trial court had recognized that the legal rate of twelve percent should be charged but inadvertently omitted it from its computation, and the spouses themselves had asked for that rate. Since only the stipulated rate was void, not the stipulation that the loan earns interest, the Court imposed a compounded legal interest of twelve percent per annum. Compounding is legal and was neither nullified below nor assailed by the spouses. The penalty, however, ranging from thirty percent and forty-one hundredths to thirty-six percent, was iniquitous, especially on top of compounded interest, and was reduced to twelve percent per annum.

On the third issue, the Court held that with a valid demand and a corrected computation, the basis for annulling the foreclosure on the ground of incorrect computation no longer stood.

On the fourth issue, the Court sustained the finding of a Truth in Lending Act violation, since the true finance charges were not disclosed.

On the fifth issue, the Court found no forum shopping warranting dismissal.

As to attorney's fees, the Court held that both parties were forced to litigate to protect their rights and both would be entitled to attorney's fees from the other, so practical reasons dictated setting them off; it merely affirmed the deletion of the award to the spouses.

Doctrine

First, under Article 1308 of the Civil Code, the validity or compliance of a contract cannot be left to the will of one of the parties. An interest rate that the lender may fix at will, whether through a branch head's determination or through a reference rate with no fixed margin, is void for violating the principle of mutuality of contracts.

Second, a reference rate is valid only if the parties stipulate a fixed margin above or below it, so that the rate is categorically determinable by simple arithmetic.

Third, estoppel cannot give validity to an illegal act or to a contract prohibited by law or against public policy.

Fourth, default commences upon judicial or extrajudicial demand, and an excessive demand remains valid as to the proper amount.

Fifth, where only the stipulated interest rate is void, the obligation to pay legal interest at twelve percent per annum survives, and a stipulation capitalizing unpaid interest is valid.

Sixth, a penalty charge that is iniquitous or unconscionable may be reduced by the courts.

Disposition

The petition was granted in part: the spouses were held liable for compounded legal interest of twelve percent per annum and a reduced penalty of twelve percent per annum, while the deletion of attorney's fees in favor of the spouses was affirmed.

Remember This

Memorize the line that an interest rate left to the lender's sole will is void for violating the mutuality of contracts under Article 1308 of the Civil Code. Examiners use this case to test the difference between a valid prime rate with a fixed margin and a void rate fixed at the lender's discretion, and to test the rules on excessive demand, legal interest, and iniquitous penalties.